Tuesday, June 2, 2009

Time to Re-think Strategy

Indian equity markets have rallied a whooping 80% in last 3 months. The rise was linear in fashion and a non-stop rally as if resembling a 'Mini' bull run. Indeed, valuations of most of the large-caps, especially selective index heavy weights, are no more in the 'Comfort Zone'. In fact, some stocks are way ahead of their current earnings performance & to support their high valuations the Analyst community have to use Forward Valuations method while recommending such stocks to their audience.

How to Shield oneself from Euphoria?

During such times, when euphoria is strong and momentum seems unstoppable, investors don't like to sell stocks with valuations beyond their comfort zone. The hope that stock will rally forward even from prevailing high valuations, does not allow the investor to book profits. Their calls are led by emotive decision to keep holding their paper profits. They are reluctant to book even part-profits.

During such times, there are few options that investors can exercise to take cautionary steps. I will divide this strategy into 2 different options in detail:

1) Book Profits in Small parts & Accumulate Cash:

Under this option, selling should carried out in those stocks where valuations are beyond the support from current earning performance. As markets rally further, the ability of such counters to appreciate further in terms of their stock prices is limited to the extent of their valuations. In fact, many-a-times, it so happens that until the over-all market momentum is up, such stocks may rise along with markets but not in line with market performance.

It is advisable to book profits in small parts on every rise in such counters. When markets starts it course of correction, these will be the stocks which will be hit hardly in the initial part of the down leg as panic is fraught where valuations are excessive or fundamentals are not up to the mark. Over here, in large-caps, the fundamentals may be sound; but valuations may be on the higher side, thus triggering sharper correction when market downturn begins.

As smaller tranches of these stocks are sold, investors can accumulate cash from sale of such stocks in anticipation of market weakness over a period of time.

2) Shift to Defensive Category Stocks:

If you don't wish to follow the above mentioned strategy of staying in Cash during an up turn, the other optional strategy could be Selling aggressive stocks or stocks with high valuations. And later switch-on to stocks from defensive category and low beta characteristics. The stocks from Defensive space holds limited potential of correcting when markets are in mid of a down turn.

At the same time, investors' wish of not liquidating even a small part of their portfolio could also be fulfilled as they do not have to liquidate their portfolio but re-jig it depending upon the current situation. They can still take advantage of the up turn in the markets to the extent of price appreciation in the defensive category stocks which of course would be limited to a certain extent during the up turn.


1) Liquidate a part of portfolio especially where valuations have gone for an over-drive. Accumulate cash to the part of the portfolio that is liquidated & use it once the down turn is more sustained and the over-exuberance is out of the context. However, you can still benefit from any incremental rally from here in the remaining major part of the portfolio they should would be still intact and invested.

2) Liquidate a chunk of the aggressive stocks and shift the accrued money to stocks from Defensive category which tend to correct relatively much less than over-valued stocks when the tide turns on the bourses. This will also ensure that you need not sit on hard cash just as the up turn wears out its last stage of euphoria.

Some stocks from Defensive Category:
Cipla, Dabur India, ITC, Marico, Glaxo Smithkline Pharma.

By using the strategy of latching on to Defensive stocks, your portfolio may underperform for a while unless the up turn continues its remaining steam. But, one another possibility which can not be ruled out is that, if indeed this is the last stage of the ongoing 'Mini' bull phase, usually such euphoric rallies end with a last leg of rally in all left-out stocks and sectors including Defensive stocks.

So, if this scenario turns out to be true, you can still benefit from price appreciation from Defensive category stocks too. One such recent example is a lagging 'Hotel' sector which showed a good move even on a slightest of a good news in the industry.

(Note: The above mentioned strategies can be used not just in the context of over-heated large-cap stocks but also any other stocks be it mid-cap or even small-cap which have appreciated substantially over last 3 months. Take, for example, you can sell some 20% of your portfolio where the stock prices have over-heated in last 10-15 sessions and shift to Defensive stocks from the accrued money.)

Dated: June 01, 2009
High Risk Call -Opportunistic Trading Bet:

Bajaj Holdings & Investments (CMP Rs.390/-)

Buy Around: Rs.370-400
Target: Rs.422-470-500
Stop Loss: Rs.355-340

Rationale: This mid-cap stock has been an under-performer in the ongoing mid-cap momentum. Bajaj Holdings & Invst. is the holding company for Bajaj Auto & Bajaj Finserv. Both the companies have rallied sharply on the bourses in last 2-3 months.

But, this holding company has not much to show in terms of price appreciation. It has fared only as a market performer & not an out-performer like other mid-cap stocks. Traders who wish to play on this aspect of under-performance can bet on this stock with above targets and Stop losses.

Its a high risk call as markets have appreciated sharply to the extent of Sensex 1000 points since last 1 week.

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jamesvaikom said...

Thanks for your article. In jan 2008 the only reason for market to go down was valuation was expensive. But now there are more than one reason for market to go down. Now the only reason for market to go up is liquidity.




Mohit said...